Groninger, 61, who retired this month from his post as a
money manager after 25 years at the bank unit of Chicago-area
First Midwest Bancorp Inc., said that in his opinion, “they
should put those sons of bitches in jail. I feel duped, I feel
lied to.”

In 2007, Groninger and his team poured about $8.8 million
of First Midwest Bank’s holdings into a slice of Acacia Option
ARM 1 CDO Ltd., underwritten by UBS AG and graded A, below the
top level while still investment grade, by S&P. It “seemed to
be commensurate with other deals we looked at,” he said. “We
looked at, or tried to, to the best of our abilities look at,
the underlying quality of the actual securities that were behind
the bond. And it still blew up in our face.”

They lost almost all of their money when the CDO defaulted
in May 2008, according to the complaint.

There’s one thing Groninger says he finds “absolutely
incredible” about the subprime mortgage disaster: “Ain’t
nobody wearing orange jumpsuits for it. No one’s gone to jail,
and I find that absolutely staggering. It’s not just the rating
agencies -- they haven’t really gone after the investment
houses.”

Deliberately Misstating

The world’s leading financial institutions suffered more
than $2.1 trillion of writedowns and losses after soaring U.S.
mortgage defaults caused the credit crunch starting in 2007.

Acacia Option is one of dozens of deals listed in a Justice
Department lawsuit against S&P and its parent, New York-based
McGraw-Hill Cos. The Justice Department accused the ratings
company of deliberately misstating the risks of mortgage bonds
to keep its share of ratings in the booming business of
repackaging home loans for sale as securities.

The suit, filed Feb. 4 in federal court in Los Angeles,
seeks penalties that may amount to more than $5 billion, based
on losses suffered by federally insured financial institutions
including First Midwest Bank.

Ratings Cut

McGraw-Hill had its credit grade cut two steps yesterday to
Baa2 by Moody’s Investors Service, its biggest rival, which
cited the lawsuit and the loss of earnings from its planned $2.5
billion sale of its education unit.

John Piecuch, an S&P spokesman, and Megan Stinson of UBS,
both in New York, declined to comment on the performance of the
CDOs.

In May 2007, S&P put its best possible grade, AAA, on 84
percent of the $500 million CDO named for a thorn tree, 98
percent of which was subprime residential mortgage-backed
securities, according to the complaint.

Option adjustable-rate mortgages, a type of loan that
allowed borrowers to pay less than the monthly interest due with
the shortfall added to the balance, were among the debt the
Financial Crisis Inquiry Commission said was at the center of
the “corrosion of mortgage-lending standards” that helped fuel
the housing boom and subsequent bust.

The bubble was inflated by CDOs, which pool assets such as
mortgage bonds and package them into new securities with varying
risks. Revenue from the underlying bonds or loans is used to pay
investors.

‘Colossally Stupid’

While about 21 percent of the collateral backing the
Acacia CDO was mortgages taken out by borrowers with poor
credit, S&P rated about $420 million of the CDO AAA, and about
$470 million A or above. The rating company confirmed its grades
on Oct. 3, 2007. Less than two weeks later, S&P downgraded
almost 14 percent of the underlying collateral of subprime
residential mortgage-backed securities.

“With the benefit of 20-20 hindsight, it was a colossally
stupid thing to do, but we had a lot of company,” Groninger
said of the investment. “The most difficult part of investing
in something new is if you don’t know what you don’t know, you
don’t completely know what questions to ask, and that was a big
problem.”

Groninger grew up in Aurora, Illinois, west of Chicago,
where his father owned a chain of coin laundries. He graduated
from Yale University in 1974 with a history degree, and was
first exposed to commodities markets at Continental Grain Co.
before joining Elmhurst National Bank, which later became Old
Kent Bank, which was in turn purchased by Fifth Third Bancorp.

Not JPMorgan

In 1987, about a month after the October market crash, he
joined First Midwest, and stayed there until retiring on Feb. 1.

First Midwest, whose Itasca, Illinois-based parent had a
market capitalization of $971 million at the end of 2008, at one
point had $65 million of asset-backed CDOs, and “lost virtually
every penny over a two year period,” he said.

“We aren’t JPMorgan with hundreds of billions of dollars
in our securities portfolio,” Groninger said. “Obviously we’re
a much smaller institution: $65 million didn’t threaten the
safety of the institution certainly, but you don’t want to do
that. It makes for some very bad days.”

First Midwest had a net loss of $26.9 million in the fourth
quarter of 2008, in part because of impairment charges tied to
investments. Three CDOs, with face value of $39 million, were
written down by $25 million, and the company cited an unrealized
loss of about $18 million on $46 million of CDOs that were
temporarily impaired.

Acacia CDO

First Midwest lost $193.7 million of cash from investing in
the second quarter of 2008, and $6.4 million and $312 million in
the next two periods, according to data compiled by Bloomberg.
By 2009, the bank had $915.8 million of inflows from investing,
and it was able to repay $193 million in Troubled Asset Relief
Program bailout funds to the U.S. Treasury Department, the
government said in November 2011.

Acacia Option ARM 1 was sponsored and managed by Redwood
Trust Inc., the jumbo-mortgage specialist. Redwood delayed
filing its 2007 annual report to evaluate declines in the value
of securities it held, after the fourth quarter’s total negative
fair-value adjustments of $956 million, it said in a statement
on Feb. 29, 2008.

At the beginning of 2008, Redwood adopted a new accounting
standard that changed the way it accounted for assets and
liabilities at its Acacia CDO entities. The Securities and
Exchange Commission demanded information about its Acacia CDO
business in May 2010 on topics including “trading practices and
valuation policies,” Redwood said in an August 2010 filing.

58 Examples

S&P said in in a Feb. 4 statement that all of the CDOs
cited by the Justice Department received the same ratings from a
competitor. Moody’s granted $420 million of Acacia Option ARM 1
CDO the same Aaa as S&P in May 2007.

S&P’s CDO group ignored warnings and data from its mortgage
securities unit that their mortgage-backed securities ratings,
used in grading CDOs, were proving flawed, according to the
complaint. The lawsuit includes at least 58 examples of S&P
executives taking steps to appease issuers or acknowledging how
pressure from banks could lessen the quality of its grades or
delay downgrades.

The ratings company contests the suit’s allegations. Even
with its best efforts to “keep up with an unprecedented,
rapidly changing and increasingly volatile environment,” the
severity of “what ultimately occurred” was “greater than we -
- and virtually everyone else -- predicted,” the company said
in the statement.

Smart Enough

“Nobody expects them to be perfect, but you at least
expect to have a modicum of intellectual integrity, if nothing
else,” Groninger said. The CDO implosion didn’t impact his
career trajectory, and no one at First Midwest blamed him, he
said.

“You can make an argument that nobody saw the depth or
degree of the train wreck that was hurtling at the economy, but
we still all got caught up in the train wreck,” said Groninger,
who earned his MBA at Northwestern University. “Yeah, I wish I
had been smart enough to ask more questions, even though I’m not
sure what questions I could have asked.”

Groninger said that “the most disappointing part of that
whole period is that you think that people at the top would have
to know that what they were doing was wrong and that it was all
a house of cards, but nobody had the balls to stand up and say,
‘this is wrong, we aren’t going to participate.’”

Invisible Hand

Groninger said he believes in Adam Smith, author of
“Wealth of Nations” and his invisible hand theory that free
markets will lead to efficiency. “Somewhere along the line that
invisible hand disappeared,” because what’s bad for customers
and the economy should also have been bad for business, he said.

The cases need to “be part of the public record” instead
of a settlement with the perpetrators paying “a big fine, or a
small fine relatively speaking, without confirming or denying
the charges against them,” Groninger said. “I hope to God they
don’t settle this one on the courthouse steps. The truth needs
to come out.”

The Justice Department case is U.S. v. McGraw-Hill, 13-00779, U.S. District Court, Central District of California (Los
Angeles).